Chinese insurers are likely to make heavier allocations towards debt in their alternative asset allocations after the country’s insurance regulator introduced new rules designed to break an implicit guarantee of the equity investment plans of fund house affiliates.

The China Insurance Regulatory Commission's (CIRC) new rules, which were released with immediate effect on January 5, are designed to prevent insurers’ asset management subsidiaries from making “fake equity, real debt” investments.

This referred to the habit of some asset manager subsidiaries of insurers of making loan-like equity investments into non-listed corporates. Most large insurers in China have asset management divisions, and they often buy these products from them.

Usually investors realise returns from investing into private companies when the latter's business flourishes, at which time the investors can sell their equity stakes at higher prices or exit through initial public offerings. But the downside risk can be a total loss of the entire investments. 

However, when asset management subsidiaries bought stakes in unlisted corporate borrowers, the corporate effectively offered a pre-agreed rate of return and certainty of payment, with other shareholders in the company committing to make up repayment shortfalls in the event of any problems.

That allowed the asset managers to deliver fixed returns and the principal to their investors, Melody Yang, partner at law firm Simmons & Simmons, told AsianInvestor. “Through those investments, they (investors) want high return with low risk, which runs contrary to investment principles,” she added.

“Fake equity, real debt” offers investors—including the insurer parents— more flexibility in their investments and better yields, Zhu Qian, an insurance analyst at Moody’s, told AsianInvestor. Plus the riskier cases could offer potential yields of 10%, she noted.

But these non-standard assets also have higher risk than corporate debts. Most of the time the structures in such investments are complex and not transparent, legal risk and counterparty risk are high, said Zhu.

The CIRC said that "fake equity, real debt", together with “channel business”—or multi-layering asset management products (AMP)—need more stringent regulations*. It also argued that local governments were on the hook in the case of any problems too, as they often acted as the effective gurantors of investments made into government projects such as public-private partnerships. 

Asset shift

The CIRC's new regulations restrict such investments from offering a defined rate of return, and prevent third parties from helping pay the investment principal. 

The new rules are to meet the country’s top agenda of curbing systemic risk in the financial system, a goal that was emphasised by president Xi Jinping in the 19th Party Congress. The regulations are also in line with the consultation paper* of the comprehensive set of asset management rules, released by the central bank and the three financial regulators in November last year, said Yang.

The new rules are likely to lead asset managers to increasingly shun these investments and could well lead to “a change in their [the insurers’] investment composition”, said Zhu. Asset managers that do not have real investment capabilities and heavily relied on channel business in the past will likely suffer too, added Yang. 

She predicted the new rules will lead insurers to shift away from the private company investments and instead put their alternative allocations into debt investment plans, trust plans and banks’ wealth management products (WMPs).

Bank WMPs have a yield of about 4.6%, but it is difficult to give an average yield level on all the available debt investment plans. However, their appeal is on the rise, said Zhu.

In the months between January and October 2017, 23 asset managment subsidiaries of insurers registered 154 investment plans, according to the Insurance Asset Management Association of China. These were comprised of 61 infrastructure debt investment plans worth Rmb191.28 billion ($29.44 billion), 82 real estate investment plans worth Rmb144.3 billion, and 11 equity investment plans worth Rmb48.85 billion,. 

There were 781 investment plans in total as of the end of October, worth Rmb1.95 trillion. But a breakdown was not shown.

Zhu said it will take time to see whether the insurers’ shift in their investment composition will cause a fall in their overall investment returns. The country’s interest rate has also rebounded of late, while the performance of the equity market, in which insurers have also invested, will play a role too, she added.  

* Highlights of the CIRC’s new rule

1. Returns from the equity investment plans should match the business profit of the non-listed corporates or investment returns of the private equity funds.

2. An expected return cannot be clearly defined, and fixed investment returns cannot be paid to investors on a regular basis every year.

3. There cannot be an agreement in which corporate borrowers or related third-party mandatorily redeem the investment principal upon maturity.

4.The asset management companies should actively conduct due diligence and cannot directly or indirectly start or involve in channel business.

5. When the equity investments are made in private equity funds, the investment amount cannot be more than 80% of the fund raised. 

*The People Bank of China (PBoC), China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC), China Insurance Regulatory Commission (CIRC) and State Administration of Foreign Exchange (SAFE) jointly released a consultation paper on regulating asset management products on November 17.

AsianInvestor is hosting its fifth Insurance Investment Forum in Hong Kong on March 1. For more details, contact Terry Rayner via email or on (+852) 3175 1963.